Reader’s Question on Brookfield Property Partners (BPY)

A reader wrote on 6/15/13:

Hi,

I am long BPY as well and not too pleased with the price action as of late, by my calculation it is trading at 0.87 book value of its underlying components (GGP, BPO, RSE) even after the REIT related sell-off and yielding closer to 4.5% .

On top of that, a hedge fund has called it a Ponzi scheme as the distributions from the components will not be enough to pay for the yield. I was just curious what your thoughts are on that point?

Thanks very much and great write-up!

Office Slice

My response:

Thank you for your comments. Your assessment is correct in my view; Brookfield Property (BPY) is trading below its book value and well below my estimates of intrinsic value. It’s not unusual for recent spinoffs to drop in price before the market begins to understand the value proposition. My investment time frame is usually 3-5 years, for many reasons, so price drops create buying opportunities.

For example, after the Brookfield Infrastructure (BIP) spinoff in 2008 the price dropped, helped along by a falling market, but the patient investors have been well rewarded and likely will be for years to come. Just so you know, after the BPY spinoff I bought more shares of both BPY and Brookfield Asset Management (BAM).

I have followed the Brookfield companies pretty closely for about 8 years and own BAM for about 7 years. So, I read the good and the bad to try to be sure I’m not missing anything. As to the short seller suggesting that Brookfield Property is a Ponzi scheme and will experience a dividend short fall; I could not disagree more.

After reading the short ‘rationale’ it reminded me of a self-serving “short and distort” attempt. In my view they picked the wrong target. They’ll find Brookfield shareholders tend to be like Berkshire Hathaway shareholders; they know when they have something good. Here are my thoughts:

1. The hedge fund says the $50 million base fee BPY pays BAM is more than BAM made before the spinoff. That’s just silly. Before the transformation to asset manager these commercial properties, under different structures, produced considerably more cash flow to BAM than $50 million. Past financial statements reflect that clearly with property funds from operations averaging over $600 million per year in 2011 and 2012, more than 10 times $50 million.

2. BPY is paying BAM $50 million for some of the best commercial real estate talent and world wide access. The fee amounts to less than 0.2% of the $30 billion in assets on BPY’s balance sheet. Hedge funds typically use the 2%-20% formula where they charge 2%, 10 times what BAM is receiving from BPY, as a base fee and then take 20% of the gains if there are any.

3. As to the need to sell assets to pay dividends; the initial dividend payout at BPY is about 80% of funds from operations (cash flow) so it is covered and sustainable with underlying multi-year lease agreements. If they continue to hit their total return targets as they historically have, cash flow will increase and provide growth for the dividend as shown on the BPY post [Source].

4. That’s not to say they will not sell assets. Brookfield is very good at acquiring real assets below replacement costs, restructuring them, keeping the gems and selling the non-core assets at a profit when the assets or markets improve. To somehow conclude this is a bad thing is beyond me.

I’ve watched them do this consistently well over the years, generating new funds to reinvest at higher return rates in core business. The recent example is Brookfield’s the announced sale of Longview timberlands and forest product companies [Source]. BAM bought the company in 2007, accumulated forest land and wood product assets, restructured the companies. The sale of these assets to strategic owners Weyerhaeuser Co and KapStone Paper and Packaging Corp “…net cash proceeds to Brookfield will be approximately $600 million, on account of its investment.  In addition, Brookfield Infrastructure will receive net proceeds of approximately $470 million”.

Generating cash to reinvest in higher return opportunities; isn’t  “buy low and sell high” what we pay asset managers to do?  That is one of the primary reasons I own Brookfield, because they demonstrated that they are good at it.

5. The company is complicated but not confusing. Master limited partnerships (MLP) combine the tax benefits of a limited partnership with the liquidity of publicly traded securities. The primary benefit of MLPs is relatively cheap funding. This is the same general partner/limited partner structure of private equity funds and used extensively in the oil and gas pipeline industry with similar investment characteristics as the Brookfield companies; real assets with stable cash flows.

6. Brookfield’s performance during the financial crisis demonstrated their access to capital. Real asset managers like Brookfield depend on the capital markets to finance large assets on a regular basis. During the financial crises when liquidity “dried up” Brookfield was one of the few companies in the world with continued access to capital. They earned that access with many investors and banks over many years of proven performance and was able to use it to acquire some tremendous bargains for shareholders during the crises.

7. I have to agree they do use financial wizardry but in a good way, along with astute business acumen, to acquire a portfolio of unique assets that would be almost impossible to duplicate. Assets that provide basic goods and services (prime commercial real estate; hydroelectric (the lowest cost) power generation; infrastructure including; ports, railroads, roadways, pipelines) with stable demand and 7-20 year contracted recurring cash flows.

8. As to communications, Brookfield provides more insight, strategic consistency, and analysis than any company I know. The long and short of it (pun intended) is you have to be willing to do the homework to understand the company. If you do, you may find it is complicated, rewarding but not confusing. I imagine Berkshire Hathaway shareholders heard comments decades ago about the confusing insurance business. They were well rewarded for doing their homework and being patient.

9. Every succeeding year Brookfield management is required to earn my confidence to keep me as a shareholder. Things don’t always go right, but management’s communications are open and honest and the fact they own 20% of the company assures me our interests are well aligned.

10. Would you short these numbers?

BAM II Investment Performance

Not me, I’m long and consider Brookfield companies core holdings based strictly on their performance.

I believe if you objectively do the homework you will want to own this outstanding company. If you don’t, perhaps your premise is wrong.

Thank you again for your comments and the best to you.

Disclosure: Long BAM, BIP, BEP, BPY, BRK

Comments

  1. Hi,

    “Coming back to Brookfield again, in April it spun off Brookfield
    Property Partners [BPY], which owns, operates and invests in high-quality commercial real estate. BPY owns trophy assets that would stand up well against any entity held by an index of commercial real estate investment trusts. But it isn’t included, or included in only a small way, because BAM still owns 90% of it and the
    float isn’t sufficient for the index. So the value-realization catalyst of the spinoff for both BAM and BPY has so far been much less operative than it would have been in the old days.”
    Source: http://www.horizonkinetics.com/docs/Value_Investor_May_2013.pdf

    I was just curious what your thoughts are on that point?
    it’s value trap ? no float = no catalyst ?

    Bye

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